Agile investors saw opportunity in January’s rates market

Published on 24 February 2021

In January, investment opportunities in the primary and secondary government bond markets allowed M&G to tap into new issue premiums and reduce risk in the local emerging market currencies, while also reflecting optimism around growth prospects in developed markets..

Eva Sun-Wai, fund manager for the M&G Global Government Bond Fund and deputy fund manager for the M&G Global Macro Fund, updates us on the need for reactive investment trading capabilities in rates markets this year.

Dan Barnes Welcome to Trader TV – your insights into trading for professional investors. I’m Dan Barnes. Today, we’re looking at the rates market in January, and joining me is Eva Sun-Wai, fund manager for M&G Global Government Bond Fund and deputy fund manager for the M&G Global Macro Bond Fund. Eva, welcome to the show.

Eva Sun-Wai Hi, Dan. Thank you for having me.

Dan Barnes So can I ask you, how active were primary and secondary markets in the rates space over January and what events were driving activity?

Eva Sun-Wai Primary markets are generally quite active in January and we saw this again this year, especially in the corporate space rates markets, also very active. We were able to be quite selective, given a wide range of choice. Fx we passed on a few eurozone new issues, but took part in some higher beta, developed markets indications such as the long end of the Portugal curve. And we also took on some New Zealand in local currency.

In secondary markets, the activity was in inflation-linked products on the back of vaccination rollouts and fiscal stimulus, as well as emerging market assets as investors hunt for yield in the current low rate world that we’re in. There’s also a lot of activity in relative value or curve trades as investors place bets on this deepening of curves, as risk assets continue their rally, or on the other hand, extend their duration risk out the curve, as they believe, valuations now look attractive at the long end and depending on views on further central bank action, et cetera.

Dan Barnes Typically we do see a lot of issuance in the credit space over January. Is it also typically true of rates as well?

Eva Sun-Wai I think so, there’s generally a bit of a wait and see towards the end of the year where central banks and corporates are more willing to raise capital in the new year. In the corporate space, I think it’s more linked to the earnings season, moving balance sheets around, et cetera, before you come to fiscal year end. In the rates space, I think it’s more of a seasonal trend. So, yeah, we do see a fair bit of activity in January, but also throughout the first quarter of the year in general, I would say.

Dan Barnes How are those trends impacting macro-bond portfolios generally, and how are you managing liquidity and volatility as the portfolio manager?

Eva Sun-Wai So in terms of our macro-bond and government bond portfolios, activity in the primary markets allow us to gain entry into bonds with new issue premiums, as well as markets that aren’t tapped into too often, where certain issuers don’t issue all the time. In emerging markets, they enabled us to reduce some risk in the local currency space after a strong rally towards the end of the year, as there were some new issues in hard currency. So we were able to do some switches from some of those local currency bonds into emerging markets, so fx those issuing in hard currency.

In terms of the secondary markets, we were able to express our views on projected inflation by picking up both index-linked bonds as well as inflation swaps in a range of markets, namely the US, but also the UK and Germany, as well as break-even curves continue to widen and markets become increasingly optimistic on short to mid-term consumption and growth prospects. In terms of liquidity and volatility, we’re able to use derivatives in the portfolios which allow us to quickly put on and remove positions. Fx using credit default swaps at an index level to gain exposure to credit markets rather than buy a bunch of physical bonds where you might have problems with liquidity. And we can also quickly remove these as credit markets tighten aggressively, which we did see last year after the initial sell-off. And in terms of volatility, these derivatives also allow us to, fx quickly hedge positions if we need to, such as selling futures to potentially hedge yield-curve steepening or hedging local FX risk by forwards, that sort of thing.

Dan Barnes What other sort of relationships and strategies are you employing in order to ensure that investors are getting the exposure that you want at the lowest possible cost?

Eva Sun-Wai M&G is very well set up to minimize costs to investors when we do trade. We have a very experienced fixed-income dealing team. We have strong relationships with a variety of brokers and it enables us to trade very efficiently. We’ve also recently added a dedicated emerging market dealer as well to expand our dealing expertize and broaden the range of the team across a lot of markets. In terms of the more sort of operational costs, we would avoid trading in tiny increments in order to minimize trading costs as much as possible. Given its size and the number of funds that we have, M&G is also very well set up to execute things such as put-throughs between funds where possible, which also reduces costs to the funds and the end investor.

Dan Barnes And then looking ahead to 2021, what do you think are going to be the big events and trends which are going to potentially impact macro fund portfolios?

Eva Sun-Wai We know the key risks to economic growth this year. I think everyone sort of does, but we have little idea of the time-scale of the vaccination rollout which will be crucial in terms of the timing of the reflation trade, fx, as the speed at which economic growth recovers will determine the speed at which central banks become uncomfortable with the level of easy monetary policy and therefore begin tapering, which could push up real yields and shift the focus away from break evens. There’s a lot of focus on the US and the US dollar at the minute. The eventual outcome that we got of the blue sweep in January has encouraged markets to review US growth prospects to the upside that has caused the yield curve to sell off, as investors expect monetary support to recede as priorities shifted to fiscal.

Again, the timing of these packages will be crucial to ensure enough is done to sustain short term growth through spending of these packages, before high savings rates can finally be deployed in the service sector, once vaccines allow those economies to re-open. The dollar, as I mentioned, is key to the outlook of a lot of FX positions whereby at the minute, markets are trading rather sideways. It’s being pushed and pulled by those who believe the dollar to be negatively correlated with equities and risk assets, as well as those, on the other hand who believe the dollar to now be undervalued, more attractive based on real yield prospects, and also attractive based on the US vaccination deployment. Vaccination brought out in the West is not the only issue, because we’ll need emerging markets to also deliver widespread immunity schemes or global tourism won’t be able to resume. The only other thing really key to this year is central bank action. Fx in Europe, the persistence of the ECB’s pet program and recovery funds should keep cool and semi-cool yields pinned, which we’re seeing in Italy, with BCP – it’s really outperforming despite the political shakeups that we’ve seen. So you might say that on a valuation basis, these are looking stretched, but if central bank support continues to remain key to keeping those yields capped.

Dan Barnes And your point about timing presumably means that having flexibility and a mandate, having the capability to use derivatives and having a stronger set of relationships with the sell-side and the good dealing team is going to be crucial to any fund, really in terms of getting that right this year.

Eva Sun-Wai Definitely, I think the difference this year compared to last year is that last year the dislocations in the market were a lot more obvious, given that we had a global pandemic that gripped the whole world. This year those dislocations are still there, but you probably have to look a little harder and you have to be more selective in where you’re going to take your opportunities. And I think the great things about our funds, as you said, is that we can quickly put on and take off positions according to when these dislocations start presenting themselves. So we are very flexible and it enables us to put quite a few different levers in order to generate performance and generate returns for our investors from different parts of the market.

Dan Barnes That’s excellent. Eva, that’s been really interesting. Thank you so much.

Eva Sun-Wai No problem. Thank you.

Dan Barnes I’d like to thank Eva for her insights today and, of course, you for watching. To catch up on our other shows or to subscribe to our newsletter, go to TRADERTV.NET or ETFTV.NET.